Startup capital raising and employee options
Capital raising and employee equity can be tricky for any startup company. You’ve got your investor meetings, legal preparations, pitching, documentation, and data room building. The list goes on. It’s a time-consuming process that oftentimes leads to a tiresome process.
We had a chat with some experts from the field in demystifying and debunking some of the complexities around capital raising and employee equity. Meet our awesome speakers below.
📣 About the Speakers
- Jason Atkins: Co-founder of Cake Equity, a company that helps businesses issue equity to employees and manage cap tables
- Melody Ashby: Senior Lawyer at Meyer Law, Ltd., a woman-owned and empowered firm that specializes in helping tech companies
- Cash Allred: Principal of Sweater Ventures, the first venture capital fund for everyday investors
- John Francis: General Partner of Stout Street Capital, a seed-stage fund that seeks to invest in early-stage companies
🍰 Slice of Cake #1: What are our options in raising capital?
As a startup founder, it’s important to know what type of entity you want to form–LLC or C Corp? Melody Ashby, Senior Lawyer at Meyer Law, Ltd. says, “A startup typically will form a C Corporation. Even if they start as an LLC, they'll eventually transition into a C Corporation. Ultimately, what that comes down to is that most investors do not want the tax liability that comes with pass-through tax entities like LLCs, partnerships as corporations.”
When it comes to vesting, Ashby believes scheduling is an important factor, “Three months from now, somebody might need to get a full-time job. So having the vesting schedule not only protects you but also the company from ensuring that you're not giving away equity and having those restrictions in place and potentially the company having rights of first refusal to reclaim any equity that's potentially vested at that point.”
As for the venture track, Cash Allred, Principal of Sweater Ventures says, “You can still raise some money from angels on a convertible note or other things and not fully commit to the venture track. But by the time you hit the seed round, it's truly a strategy of go big or go home when you start taking institutional money for many funds.”
"It's very important to not just have the legal and cap table clean, but to be able to speak to the strategy as to why you did it that way, why you split your equity the way you did, and have those answers readily available. Because as the investor, I want to make sure that I can get inside your head and understand your strategy and know that there is a strategy and that there were conversations and thoughts behind those things." - Cash Allred
🍰 Slice of Cake #2: Why are terms important?
There are multiple ways to go about producing your term sheet. Recently, Francis has been seeing big impacts from the later stage startups, “B and C stage companies have been hit the hardest in terms of valuations, in terms of changes in that term sheet, getting more aggressive and master friendly terms. So some of the things that we are seeing is a pretty high preference stack. We are seeing higher liquidation preferences. We're seeing tier liquidation preferences.”
According to Francis, the earlier stage C is where he sees the biggest hurdle since price confusion comes about, “You're seeing a lot more uncapped bridge rounds, which is an easier way for investors to say like, ‘Hey, I'll pump this to the next investor until they figure out what the pricing or the valuation for this company is.’ Also, even if there is a possibility of a down round, having an uncapped bridge round allows you the ability to keep the company afloat and keep the company running until the next round.”
Allred adds, “Some challenges and mistakes that I've seen made in this last year are some entrepreneurs raising on a safe. Last year at one term and then raising this year on a safe at different terms and not going back and cleaning that up moving forward. So that can create problems. One, your investors can get unhappy with you and each other if they're given different terms within a fairly close timeframe. And two, it raises questions down the line like, oh, did you just have a hard time raising so you had to reduce the price and you didn't bring other people in? Are you going to treat me poorly? And so I think you have to be thoughtful if you are doing a bridge round between this to make sure that you're treating all of your investors fairly and transparently through that process.”
For Ashby, it also helps to not deviate too much from the market and stick to standard terms. Getting creative can be a good idea, but in some situations, it can end up complicating things.
Atkins’s view is to keep the safe terms as consistent as possible because that is the fair and right thing to do.
🍰 Slice of Cake #3: Some tips on pitching!
Atkins begins by saying you have to pitch to your superpower.
"You've got to make investors feel like you can change the world in some way… Make sure you understand where your superpower is and get some coaching and get feedback as necessary to make sure that your pitch is hitting the mark." - Jason Atkins
Ashby goes on by stating that networking matters, “Ask for introductions, see who's connected to which individuals. And then when you meet with investors, ask for additional intros and that's how I feel like most startups will fill out their round.”
Allred says, “Only thing I would add is an overlooked source of introductions to VCs are your peers. Other entrepreneurs, any entrepreneur who's closed a Cedar Series, a round pitched 10 times, the number of investors that they actually raise money from, and they likely still have those lists. And it's a great way to both become aware of more funds that you may have overlooked or get intel on which funds play and which spaces.”
🍰 Slice of Cake #4: How does one set up an equity plan?
When you’re starting to build your team is the perfect time to get your equity plan in place, says Atkins. “It really puts some skin in the game and professionalizes that relationship and it builds trust.”
But how do you map your equity if different people are doing different things? Francis believes it depends on what value or skill set your employees are bringing and at what level, “If they're co-founders, obviously you're giving them a little more equity. Having a clear resting schedule for your leadership team allows you a little more stability. And also, it is a way to make sure your early talent stays with you until your growth goals or at least your early stage goals are achieved.”
For Allred, it helps to really look into your candidates, “It's helpful sometimes to sit down when you're looking at a candidate to say, what is the impact this candidate's going to have on the business? And what is my budget, both with Allred and equity for this role based on the amount of value I'm expecting to get out of it over the next two to four years during the investing schedule?”
Ashby adds, “Everybody's going to be a little bit different and it's going to be dependent on the level of involvement.”
She then continues by reminding us to have proper authorizations in place, “Your board and your stockholders have to approve the plan. Depending on your voting thresholds and levels. Your board should always be authorizing and approving every equity award.”
When it comes to stock options, one of the biggest issues Francis sees is people running out of options quickly or not deploying funds fast enough. But one of the biggest mistakes is not using funds to the fullest extent possible, “What we've seen is people kind of underutilizing them. They hold onto it for a long time. So between funds, we see a lot of carry-over options moving between funds, between stages.”